Advanced Medical Optics (EYE)

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Katerina Semida

As its ticker suggests, Advanced Medical Optics (EYE) manufactures medical devices for the eye. Its products range from simple contact lens cleaning solution to lens implants for cataracts and devices used in laser vision correction surgery. About half of all sales in 2006 came from its cataract division. Spun off from Allergen in 2002, Advanced Medical Optics has since grown through strategic acquisitions. It has nearly doubled its sales from 2002 to 2006, when it generated revenues of approximately $1 billion.

As a company dependent on cataracts patients, the company is positioned to benefit from the aging of baby boomers in the U.S. Adults between the ages of 52-64 have a 50% chance of getting a cataract, and, by age 75, virtually everyone suffers from the condition. Based on U.S. census demographics, the number of boomers over the age of 65 will increase 20% in 2030 to 69 million individuals.

Its dependence on the cataracts industry (it makes half of its revenues from it) is tempered by negative trends in its other divisions. Laser vision correction is not covered by Medicare, Medicaid or most private insurance plans so demand for the expensive procedure tends to be correlated with economic conditions. The number of LASIK procedures from 2004 to 2006 has been flat at 1.3 million per year. In addition, the company's contact lens solution is a peroxide-based product, which have rapidly lost ground to less expensive and easier-to-use "no rub" solutions.

Business Overview

Spun off from Allergen in 2002, Advanced Medical Optics manufactures medical products for the eye along three product lines:

• Cataract/implant: The cataract/implant business is AMO’s largest division, accounting for 52% of 2006 sales. AMO’s products in this division include artificial lens for insertion into the eye during cataract surgery and various devices which aid in the implantation of the lens.

• Laser Vision Correction: Laser vision correction accounted for 22% of 2006 sales. Products consist of laser systems, diagnostic devices, and other tools for use in laser eye surgery.

• Eye Care: 26% of 2006 revenues originated from the eye care division, which sells various contact lens cleansing solutions. This division has recently experienced difficulties following a May 2007 product recall (Complete MoisturePlus lens cleaning solution). AMO announced operating losses of $166.8 million and $25.9 million in the second and third quarters of 2007, respectively. Although AMO reintroduced a reformulated version of the product less than 90 days after its recall, the eye care division has not yet completely recovered from this event. ^[1]

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AMO's three product lines are complementary, allowing for cross marketing efforts. ^[3] Furthermore, seasonal sales trends in all three product lines tend to be balance each other out. For instance, cataract/implant business sales are usually low in the first quarter and gradually increase throughout the rest of the year. In the laser vision correction business, however, the highest portion of sales is concentrated in the first quarter. Combining these product lines smooths earnings throughout the year.

Financials

Company revenues have grown from $538.1 million in 2002, (when it became an independent public company), to $997.5 million in 2006, implying an annual growth rate of 16.7%. Revenue growth was bolstered partly by acquisitions, most notably that of Pfizer’s ophthalmic surgical business in 2004 and VISX (the leading manufacturer of LASIK equipment) in 2005. Primary drivers of 8.3% revenue growth and 18.6% operating income growth from 2005 to 2006 included the full-year impact of the VISX acquisition and international expansion of the laser vision correction business. ^[4]

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Key Trends, Risks and Forces

General

• FDA Regulation: AMO's products and operations are subject to extensive regulation at all stages in the production process - from clinical and pre-clinical testing to marketing and advertising. Receiving FDA clearance is a time-consuming and costly process; planned product launches must often be delayed due to slower-than-expected progress. For instance, the release of the cutting-edge Tecnis Multifocal (MF) surgical lens, originally scheduled for mid-2007, was delayed by 12-18 months following the FDA's requests for further clinical trials . Furthermore, FDA clearance can be easily revoked at any point, as attested by AMO's recalls of the Complete contact lens solution in 2007 and 2006. Such recalls can be costly: one in the 2nd quarter of 2007 cost the company $81 million. Key AMO products currently awaiting FDA approval include over-the-counter (OTC) dry eye solution (the company's first venture into this market) and a next-generation multipurpose lens solution. AMO's profitability partially depends on when (and if) these products make it through the FDA pipeline. ^[6]

• Foreign Currency Exchange Risk: 58% of AMO's sales are made outside of the United States and thus involve foreign currency. When the US Dollar falls in value against major currencies such as the euro and the yen, foreign currency translation effects increase revenues. This has been the case for most of the company's history, from 2002 to mid-2005. In 2005-2006, the dollar's slight rise in value actually hurt revenues; however, more recently, the continued depreciation of the dollar has again begun to contribute positively to AMO's profits, raising 3rd quarter 2007 sales growth by 2.1%. ^[7]

• Regulation and Demand for Medical Devices in Japan: AMO's products are sold in over 60 countries; after the United States, the company's largest market is Japan, accounting for 14% of revenues.^[8] Japan's demographics favor AMO's continued expansion. The nation has one of the highest life expectancies in the world, and a rapidly aging population (over 20% of the population in 2007 was 65 or older), resulting in rapidly growing demand for healthcare services. The primary regulatory authority in Japan for the healthcare industry is the Ministry of Health, Labor, and Welfare (MHLW). However, currently, the government is attempting to shorten the lengthy period of the approval cycle for new products and technologies by creating a new organization to approve medical devices and pharmaceuticals. The success of this initiative may ease the introduction of new products into the Japanese markets, positively impact AMO as it expands its operation in Japan.

Segment-Specific

• Growing Need for Cataract Surgery as Baby Boomers Age: The incidence of cataracts is dirrectly correlated to age. Individuals between the ages of 52-64 have a 50% chance of getting a cataract, and by age 75, virtually everyone suffers from the condition. The aging baby boomer generation, the oldest members of which turn 60 this year, will contribute to the continued demand for cataract surgery. Because they make up over a quarter of the US population, baby boomers stand to make a huge impact on the demographic composition of the nation. While in 2007, only 13% of the US population is 65 or older, the aging of the baby boomers is expected to raise this number to over 20% by 2030 (to 69 million.)^[9] With over 2.8 million people undergoing cataract surgery each year, the procedure is already the most frequent non-elective surgical procedure in the United States. This number is likely to increase rapidly as the baby boomers continue to age, fueling the demand for products from AMO's largest division. ^[10]

• Flat LASIK Demand: Because laser vision correction is not covered by Medicare, Medicaid, or most private insurance plans, consumers must pay directly out of pocket for such surgeries. As a result, demand for LASIK tends to be heavily correlated with economic conditions, especially in the U.S. A weak or uncertain economy can decrease sales in the laser vision correction division.^[11] Furthermore, concerns about the safety of LASIK procedures have been increasing over the last few years. Some studies have found that as many as 18% of LASIK patients need retreatment. ^[12] The negative publicity resulting from such findings, as well as media coverage of individual negative experiences with LASIK add another downward pull to already weakened demand. Consequently, laser vision correction has been a flat market for the past few years, with roughly the same number of LASIK procedures performed each year (see chart below).

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• Decline in the use of peroxide-based contact lens solutions: AMO's eye care products consist of traditional peroxide-based cleansing solutions. In recent years, these have rapidly lost ground to less expensive and simpler-to-use multipurpose "no-rub" products. The increased popularity of other alternatives, such as disposable contact lens and laser vision correction, is hurting sales of peroxide solutions as well. A continued increase in demand for these substitute products would reduce the profitability of AMO's eye care business. However, AMO is betting on the fact that peroxide-based cleansing solutions disinfect lens more effectively; it may be that increases in lens-related eye infections (such as the Acanthamoeba keratitis outbreak in 2007) will raise demand for its eye care products.^[14]

Competition

Advanced Medical Optics (AMO) competes in three segments of the ophthalmic market – cataract/implant, laser vision correction and eye care. AMO is one of the top three players in the industry, with ALCON (ACL) and Bausch & Lomb (BOL) its primary competitors. Smaller firms that compete with AMO in only one or two markets include STAAR Surgical Company (STAA), Eyeonics, Japanese companies Hoya and Santen, German company Zeiss-Meditec, and Corneal. One of the company's primary competitive advantages is its large global network, as the company makes more sales outside of the U.S. (58% of 2006 sales from international). Additionally, after the acquisition of VISX, the company's laser vision correction business is the world’s largest (see chart below).

However, AMO is smaller in size than its main competitors, and thus has access to fewer resources in areas such as R&D, marketing and sales, which hurts its competitiveness. ^[15]

• Bausch & Lomb (BOL): With annual sales of over $2 billion, B&L is twice AMO's size and offers cataract, laser vision correction, and eye care products, among others. B&L is particularly strong in the eye care segment, where annual sales of its ReNu contact lens solution are three to four times as high as AMO's Complete brand. However, the company's largest segments by far are pharmaceutical product and contact lens manufacturing, markets in which AMO does not compete. ^[16]

• Alcon (ACL): Alcon owns the largest global cataract/implant business in the world, and the robust growth of this division (8-12% annually) far outpacing that of AMO and B&L (3-4% annually). Alcon spends over 10% of revenues on research and development, which is one of the highest rates in the industry. ^[17]

Laser Vision Correction (LASIK) Market Share

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Footnotes

1. ↑ Webb, Jennifer A. "AMO re-enters multipurpose solution market." Ophthalmology Times; 8/15/2007, Vol 32 Issue 16, p 3-6
2. ↑ 2006 10-K, Item 7: Management’s Discussion and Analysis, page 34
3. ↑ AMO Corporate Website
4. ↑ 2006 10-K, Item 1: Business, page 12
5. ↑ 2006 10-K, Item 6: Selected Financial Data, page 28
6. ↑ 2006 10-K, Item 1A page 18
7. ↑ AMO Website Press Releases. "Advanced Medical Optics Announces Third Quarter 2007 Results."
8. ↑ 2006 10-K, Item 1: Business, page 14
9. ↑ "Growing Old, Baby-Boomer Style." CBS News.
10. ↑ TLC Vision 2006 10-K, Item 1: Business, page 5
11. ↑ 2006 10-K, Item 1: Business, page 21
12. ↑ "Lasik has 10% failure rate"
13. ↑ TLC Vision 2006 10-K, Item 1: Business, page 5
14. ↑ Webb, Jennifer A. "AMO re-enters multipurpose solution market." Ophthalmology Times; 8/15/2007, Vol 32 Issue 16, p 3-6
15. ↑ 2006 10-K, Item 1:page 12
16. ↑ Bausch & Lomb Corporate Website www.bausch.com
17. ↑ Alcon Corporate Website www.alcon.com
18. ↑ Alcon, AMO, Bausch & Lomb Annual Reports. www.sec.gov